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Monday, December 29, 2014

Sunk Cost Fallacy: Do Children and Animals Avoid It?

The sunk cost fallacy appears in every introductory economics course. Rational behavior suggests that people should realize that they can't change the past. The amount of money or time or energy that has already been spent on some project is a "sunk costs," and it should be irrelevant to whether you keep going with the project. When making a choice, you should look only to the future costs and benefits of your actions.

Many people find it hard to disregard sunk costs. There are the romantic relationships that have been lukewarm or worse for a long time, with no likely prospect of change, but where one or both people can't break up because they've been together for so long. There are the investors whose stock portfolio or house has lost value, but who doesn't sell because if they just keep holding on, they can pretend that those losses haven't yet happened. There are large projects in business and government where a lot has been spent in the past, and so the project must be continued into the future--even though its prospects appear grim. Indeed, the sunk cost fallacy is sometimes called the "Concorde effect," after the supersonic jet where development and construction went on long after it was clear that the project was not economically viable.

Some evidence suggests that children and animals may be better at avoiding the sunk cost fallacy than adults. At some level, this makes sense. After all, children and animals may be less likely than adult humans to become ego-involved and locked down into what happened in the past, and thus more likely only to look forward. But I'll also admit that, at some level, this theory also sounds a bit ridiculous to me. How does one test whether children and in particular animals take sunk costs into account? The classic discussion of the evidence here here seems to be a 1999 paper by Hal R. Arkes and Peter Ayton called "The Sunk Cost and Concorde Effects: Are Humans Less Rational Than Lower Animals?" It appeared in a 1999 issue of Psychological Bulletin, published by the American Psychological Association (125:5, pp. 591-600). The journal isn't freely available on-line, but many readers will have access through a library.

As one example, here's a discussion from Arkes and Ayton of a study looking at whether female albino mice take sunk costs into account, or focus only on the future.

A prototypical study ... tested the litter defense behavior of female albino mice. On the 8th day of a mother's lactation period, a male intruder was introduced to four different groups of mother mice and their litters. Each litter of the first group had been culled at birth to four pups. Each litter of the second group had been culled at birth to eight pups. In the third group, the litters had been culled at birth to eight pups, but four additional pups had been removed 3 to 4 hr before the intruder was introduced. The fourth group was identical to the third except that the removed pups had been returned to the litter after only a 10-min absence.

The logic of the Maestripieri and Alleva (1991) study is straightforward. If each mother attended to past investment, then those litters that had eight pups during the prior 8 days should be defended most vigorously, as opposed to those litters that had only four pups. After all, having cared for eight pups represents a larger past investment than having cared for only four. On the other hand, if each mother attended to future costs and benefits, then those litters that had eight pups at the time of testing should be defended most vigorously, as opposed to those litters that had only four pups. The results were that the mothers with eight pups at the time of testing defended their litters more vigorously than did the mothers with four pups at the time of testing. The two groups of mothers with four pups did not differ in their level of aggression toward the intruder, even though one group of mothers had invested twice the energy in raising the young because they initially had to care for litters of eight pups. Thus, the magnitude of expected benefits, not the amount of prior maternal investment, determined the mothers' defensive behavior.

Arkes and Ayton also discuss a number of other animal studies: the behavior of a kind of fish called a convict cichlids (Cichlasoma nigrofasciatum); a study about how female digger wasps provide dead katydids for their larva to consume; the nest defense behavior of savannah sparrow; and others. They discuss alternative interpretations of these studies, but argue that the results generally support the claim that animals don't take sunk costs into account.

What about studies of children? They discuss a 1997 study that tested children in the age groups 5-6, 809 and 11-12 with this question:

Imagine you are at a fairground with your parents. Your mother gives you a 50 pence coin, and your father gives you a one pound coin.After walking around for a while you decide to use the 50 pence cointo buy a ticket for the merry-go-round. [But then you discover that you have lost your ticket./But then you discover that you've lost the 50 pence coin so you can't use it to buy a ticket for the merry-go-round.] Would you use the one pound coin to buy a new ticket? Half the children in each of the three age groups received one of the two sentences inside the brackets. ... [For the older children, when] the money was lost, the majority of the respondents decided to buy a ticket. On the other hand, when the ticket was lost, the majority decided not to buy another ticket. This difference was absent in the youngest children. Note that it is not the case that the youngest children were responding randomly. They showed a definite preference for purchasing a new ticket whether the money or the ticket had been lost. Like the animals that appear to be immune to the Concorde fallacy, young children seemed to be less susceptible than older children to this variant of the sunk cost effect.

Arkes and Ayrton cite some other evidence, not directly related to the sunk cost fallacy, that in some cases young children may act more in accordance with strict rationality than older children or adults, because adults are prone to more complicated strategies, while children don't overthink the situation. Here's a discussion of another study with younger and older children:

The participants ranged in age from 3.6 years to 18 years. Each of them faced a panel containing a horizontal row of three knobs, above which was a signal light and below which was a delivery mechanism for marbles. On each of 80 trials, participants were told to press one of the three knobs. Correct presses would be followed by the delivery of a marble. For all participants, pulling one particular knob was followed by reinforcement, but at a 33% rate for some persons and at a 66% rate for others. ... A participant was deemed to be a "maximizer" if the correct knob was pulled on at least 18 of the last 20 trials. ... [T]he youngest children were more likely to be maximizers than were the participants of any other age. Weir (1964) attempted to explain these surprising results:
"It is likely that the 3- and 5-year olds are drawn to the payoff button on the basis of a simple reinforcement notion only. . .. Older subjects . . . employ complex strategies. . . . It is interesting to note that . . . the belief that there is a complex solution actually results in fewer choices of the most frequently reinforced alternative ... The older participants were `too smart for their own good.'"

The exact reasons why people pay attention to sunk costs are not clear. One hypothesis is that people or organizations just don't like admitting error. Another hypothesis is that when disregarding sunk costs feels wasteful in some way, and people don't like to waste. Yet another hypothesis is that in many aspects of life, there is a positive correlation between past efforts and future payoffs, and so giving up on a project with large sunk costs feels like it is also giving up on future payoffs.

As noted earlier, I'm not confident about interpreting some of the evidence about animals and young children as a strong demonstration that they do ignore sunk costs. But I'm always looking for a lively way to explain basic economics concept to students. Explaining some of the evidence that animals and small childen may be better able to disregard sunk costs--appropriately hedged with caveats-- couuld help some students remember the concept of sunk costs more clearly.